The current situation offers an opportunity to strengthen the business environment and enhance fiscal space even as the reform momentum has accelerated in the past few months, Rama added. Activity is expected to pick up strongly in the last six months of the fiscal year, rising above 6 per cent in the fourth quarter of the current fiscal, the World Bank said.

This will come as financial markets stabilise, exporters take advantage of improvements in external competitiveness following the depreciation in the rupee, the manufacturing sector recovery continues and delayed investment projects begin to come on stream.

Pressure on inflation is likely to moderate, the World Bank said. The bank cut its projection for wholesale price index (WPI) inflation to 5.3 per cent for the current financial year against its earlier forecast of 6.7 per cent.

The downward momentum in core WPI inflation, observed throughout calendar 2013, is expected to continue in 2013-14, it said.

Six consecutive quarters of sub-6 per cent growth have allowed for an opening of the output gap, which is likely to limit inflationary pressures even with the expected acceleration in economic activity during the forecast period, the bank said.

Fuel prices, on the other hand, will continue to add to the inflationary momentum as international oil prices are likely to remain elevated throughout the forecast period.

"Altogether, WPI inflation is expected to average 5.3 percent in the current fiscal year and decelerate further to 5.2 percent in 2014-15 as pressure from food prices declines due to an improvement in agricultural output," it said.

On the current account deficit (CAD), the report said, it is expected to narrow to 4.1 per cent of GDP in the current fiscal against an earlier projection of 4.5 per cent.

"The first quarter of FY2014 witnessed a widening of the trade deficit as the depreciation in the rupee and inelastic demand for imported oil – which accounts for more than one-third of total merchandise imports – have kept imports elevated while the exports response was subdued," it said.

In July and August, exports rebounded strongly and imports came down, and a continuation of these trends is expected to bring down the trade deficit in the quarters ahead, it said.

Although overseas shipments are expected to rise overall, the export response in the manufacturing sector could be muted due to the rising costs of imported intermediate inputs, especially as metal prices are expected to remain elevated throughout